Are virtual assets taxable?

Journalist and "Ultima Online" junkie Julian Dibbell issued himself a very public challenge two years ago.

"On April 15, 2004, I will truthfully report to the IRS that my primary source of income is the sale of imaginary goods," Dibbell wrote on his blog at the time, "and that I earn more from it, on a monthly basis, than I have ever earned as a professional writer."

Essentially, he was telling the world he thought he could make a profit selling to other players in the real world the weapons, currency and other goods he had accumulated in the fantasy game "Ultima Online," and that he was willing to tell the IRS so. He ultimately came up short in his personal challenge, making more from his writing, in fact, than from his online trafficking.

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What's new:
Some wonder whether valuable goods frequently bartered in the online game world can be deemed a taxable possession before they are sold for real-world money.

Bottom line:
Some say there's no theoretical reason the government shouldn't come calling for its fair share of valuable game assets that haven't been sold for real-world money. But observers of online games worry that the IRS doing so could be a disaster.

Now, with a , Dibbell has the virtual-world community buzzing over a new question: Should online game players' assets--the weapons, characters, clothing and such--they've accumulated but not yet sold for real-world cash be taxable by the IRS?

"If you haven't misspent hours battling an Arctic Ogre Lord near an Ice Dungeon or been equally profligate spending time reading the published works of the Internal Revenue Service," Dibbell's essay begins, "you probably haven't wondered whether the United States government will someday tax your virtual winnings from games played over the Internet. The real question is: Why hasn't it happened already?"

It's a question insiders at academic conferences like State of Play that study online games have been talking about for some time.

After all, since the trafficking of virtual goods from games like "World of Warcraft," "City of Heroes" and "Star Wars Galaxies" on exchanges like eBay sets their fair market value, the millions of online game players are collectively holding tens or even hundreds of millions of dollars' worth of these digital assets at any one time. And some would say that's a target the IRS can't ignore forever, raising the tricky question of whether virtual goods that are frequently bartered and exchanged in the gaming world can be deemed a taxable possession before they are sold for real-world money.

I just don't think it would be the catastrophe that everybody imagines.

--Julian Dibbelljournalist

While most online game publishers try to sidestep the issue by saying in their terms of service that players don't control the property rights to their game assets, some say there's no theoretical reason the government shouldn't come calling for its fair share.

"From the standpoint of economic theory...there's no fundamental distinction between selling euros and buying magic wands," said Ted Castronova, an expert on virtual economies and an associate professor of telecommunications at the University of Indiana at Bloomington. "They carry value with them. If you're going to tax exchanges in the real world, you've got to tax exchanges in the virtual world, in economic theory."

The problem, said Castronova, is that it's not about economics.

"It's about common sense," he said. "Common sense says that when people are playing a game of Monopoly, you don't tax (the properties they buy and sell)."

Dibbell isn't so sure. He said that while the IRS has ruled that some forms of goods with inherent value--such as then St. Louis Cardinals star Mark McGwire's record-breaking home run ball from 1998--are not taxable assets until they are sold, that may not always be true.

"As the RMT (real money trading) markets get bigger and more normalized, how long are the tax agencies of the world going to forebear?" Dibbell asked during an interview with CNET News.com. "At a certain point, it will be less crazy-looking to everybody and therefore more palatable, and there will be more money involved."

No one knows the exact worth of the virtual assets of the millions of online game players. But with estimates for the sales of such goods going as high as $880 million a year, the unconverted assets are surely worth similar amounts. Thus, the government's share, if the government were ever to lay its claim, would be substantial.
But observers of online games worry that the IRS doing so could be a disaster for online games. That's because it would require the constant tracking of the value of every kind of in-game asset and of all nonmonetary transactions.

"That would be an apocalypse for developers," said Matt Mihaly, CEO of Iron Realms, which publishes such online games as "Imperian" and "Lusternia." "I think it would make running (massively multiplayer online games like "EverQuest" or WoW) an unprofitable business to be in, except for the biggest publishers. We'd spend all of our time tracking deals between players. I don't know how we'd deal with the fact that we're creating wealth every time a monster makes a drop, or there's a reward."

Castronova agreed.

"There would have to be a reporting requirement," he said. "Everybody playing in a virtual world game would have to keep track of what their income is in gold pieces."

And Castronova doesn't think such an imposition by the IRS would be a good idea.

"That would be insane," he said. "You could do it. But it would just be a ridiculous burden. These game companies would have to keep a digital record of players' income and sales...It would generate a lot of paper. You'd have to set aside a lot of servers to keep records. It would add to the cost of games."

To Joseph Bankman, a professor at Stanford Law School, the question is not one game players or publishers should worry too much about.

"I think the common-sense answer is that the IRS wouldn't and shouldn't go after folks until they sell the assets," Bankman said. "The common sense reason for this is that for most folks, the 'assets' represent enjoyment value--what we call imputed income--that's not taxed. It's a little bit like getting an autograph of a baseball player or movie star. You could sell the autograph, and folks do, but we don't tax folks who get the autographs and don't sell them."

For its part, the IRS would say only that it expects players to report any real-world earnings from the sale of virtual goods. But in his article, Dibbell said the agency had suggested it might consider at least some of the assets taxable barter goods.

In any case, Dibbell isn't sure the future of online game playing will be free from tax forms.

"I just don't think it would be the catastrophe that everybody imagines," he said. Gamers "can say it has no value, but if they go out and participate in the RMT markets, the IRS is going to say money talks...(and that) you guys are the ones valuing this stuff, not us."

But Castronova hopes the IRS would see the social value of staying away.

"What would be nice would be a conversation between the IRS and the National Science Foundation," he said. "The NSF might say these worlds are really important social investigation tools and that if we treat them as an extension of the real world, they'll lose their value as a place where we try out social experiments."